Private credit can offer several advantages over traditional fixed-income securities, such as Australian and U.S. government bonds, primarily due to a better yield and flexibility of terms. In private credit, investors are equivalent to bank depositors, while private credit funds are equivalent to banks. The availability of Private Credit has created a boon for investors, particularly when compared to traditional government bonds or equities. While private credit remains the hottest asset class on investors’ minds, it’s paramount for investors to discern how the systems and processes of a private credit provider add value and security to an investment.
The reason why government bonds play a role in protecting assets is that it is a traditional safe harbour asset in an economic downturn. The benefits of bonds are that they provide a consistent income at a premium compared to the cash rates; investors are compensated for the time it takes for a government bond to mature. However, the risks of fixed-income securities are also often overlooked and misunderstood. Bonds are dynamic and their value is a function of the time to maturity, interest rate sensitivity (particularly in a rising interest rate environment) and their yield. This was particularly evident from 2020 until now, where bonds have provided negative returns (so much for capital stability!). Long story short, the longer the time horizon of a government bond, the greater the probability that random events could occur, which could affect investor returns.
There is also consideration as to how private credit providers compare returns to equities. In recent times, market returns have been compelling and reached new heights on the major indexes. The financial reality is that all asset classes revert to the mean. The U.S. yield curve has just come out of its inversion, while the spread between US Treasuries and Corporates has been narrowing in 2024; Moody’s AAA Bond yield was reported at 4.68%, a 1% difference between US Treasuries. Now, while these signals are ‘priced-in’ and don’t guarantee the impending collapse of markets, they are leading indicators. Is it a prudent opportunity for investors to take some gains off the table?
The systems and processes behind private credit providers are the most important thing when considering an investment. Private credit isn’t a ‘carte-blanche’ one-size-fits-all approach to investing, as there is a spectrum of private credit providers that specialise in a range of different loans. The underlying securities of the loans will also differ in risk profile from the unsecured, structure of a loan, mezzanine, vetting processes of the loanee and how highly leveraged the book is. More importantly, when selecting a manager, it is important to consider the qualitative aspects of their style; the key questions investors should be asking are:
- Do they have skin in the game?
- What is their experience and expertise within their niche?
- Are they disciplined and rigorous in vetting their loans?
- Liquidity. Are the funds locked up for a period, or how long until they can be liquidated?
- What is the loan collateralised against?
Case Study
Barry is a retiree with a traditional 60/40 equity to fixed income split in his superannuation account. He also had a spare $400,000 cash sitting on the sidelines, while also an equity portfolio of $250,000 in his name. Given the heightened geopolitical risk, Barry questioned whether the risk versus the reward of an equity portfolio warranted a review, all the while not wishing for the cash reserves to be eroded by inflation.
His objective was to take $50,000 gains off the share portfolio so that it did not affect any capital gains and maintain a cash buffer of $150,000 for a medical emergency or the ability to buy the dip in a market downturn.
His discussion with a financial adviser centred on the allocation of a portion of his funds, agreed to an even split of five reputable private credit providers, and diversifying across differing loans. The investor’s objective was to generate a return of 4% above the cash rate while reducing the volatility of his portfolio for 12 months.
| Before | After | ||
| Share Portfolio | $250,000 | Share Portfolio | $200,000 |
| Cash | $400,000 | Cash | $150,000 |
| Private Credit | $0 | Private Credit | $300,000 |
| Spi | 10% | Spi | 10% |
| Ci | 4.50% | Ci | 4.50% |
| Pci | 9% | Pci | 9% |
| Total 12-month Return | $39,000 | Total 12-month Return | $52,250 |
| 6.00% | 8.00% | ||
Want to Learn More? Click here to see our Private Credit offerings from Rivkin Private Wealth.*
*Rivkin Private Wealth Private Credit products are intended for wholesale investors only.
Conclusion
Private credit remains a sub-asset class that can generate consistent and generous returns, particularly when compared to the yield of a traditional fixed-income bond and on a risk-adjusted basis to an equity portfolio. While it is ‘in vogue’ amongst investors, diligence and prudent consideration should be top of mind as there is a range of providers who will vary in expertise, quality, and discipline.
